FMV lease vs. $1 buyout lease

The two lease types in one paragraph each

Fair market value (FMV) lease. You rent the equipment for a set term. At the end you can return it, renew, or buy it at whatever it’s worth then. Payments are usually lower, because the lessor expects to get value back from the equipment. For tax purposes, a true FMV lease is generally a rental: you deduct the payments as a business expense and the lessor depreciates the equipment.

$1 buyout lease (also called a capital lease or conditional sale). You make fixed payments and own the equipment at the end for a nominal $1. Payments are higher, because they cover the whole cost plus financing. For tax purposes, it’s generally treated as a purchase financed by the lessor: you depreciate the equipment (including under Section 179, if eligible) and deduct the interest portion of the payments, not the payments themselves.

At a glance

How to find the interest rate in a $1 buyout lease

Lessors often quote a $1-buyout lease as a monthly payment, or a “lease rate factor” (payment ÷ cost), rather than an interest rate. You can recover the rate: it’s the rate at which the payments, plus the $1, repay the equipment cost.

For a $100,000 machine:

Timing matters: paying at the start of each month means you’re repaying sooner, which raises the effective rate. Most equipment leases are billed in advance, often with the first payment (and sometimes the last) due at signing.

A worked after-tax comparison

Here are three ways to get the same $100,000 machine for five years. Assume a combined 25% tax rate, a 9% borrowing rate for discounting, full first-year expensing where you own the equipment, and a $25,000 resale value after five years.

The FMV lease has the lowest payment and costs $12,001 less in total cash ($114,000 vs. $126,001). Yet it’s the most expensive option after tax and in today’s dollars. Two things tip it:

1. You keep a $25,000 machine with the buyout lease or the loan.
2. Owning lets you deduct the full cost in year one. That’s a large, early tax saving compared with deducting lease payments evenly over five years.

The buyout lease costs a little more than the bank loan here because its implicit rate (9.85%) is higher than the loan’s 9%, and payments start at signing.

The residual value decides it

The resale value is an estimate, and it drives the result:

The FMV lease cost doesn’t move, because you hand the equipment back. If the machine will be nearly worthless in five years, the two options are almost equal. An FMV lease is essentially insurance against obsolescence: you pay for the certainty of walking away.

When an FMV lease makes sense

• Technology that dates quickly, such as computers, medical imaging or telecom equipment, where you’d upgrade before the equipment wears out.
• You don’t have enough taxable income to use a large first-year deduction, so owning doesn’t bring the tax saving forward.
• You want lower payments to preserve cash for the business, and accept a higher long-run cost for it.
• Maintenance is bundled. Some FMV leases include service. Subtract its value from the payment before comparing.

When a $1 buyout lease makes sense

• Long-lived equipment you’ll keep well past the term: machine tools, vehicles, restaurant or construction equipment.
• You want the first-year deduction. Owning makes Section 179 or bonus depreciation available. The 2026 Section 179 limit is $2,560,000, phased out dollar for dollar once you place more than $4,090,000 of qualifying property in service in the year.
• The lessor is the easiest financing to get, for example through a dealer, even if a bank loan might be a little cheaper.

Watch for these in the paperwork

• “FMV” purchase options that aren’t really FMV. Some leases set a fixed purchase price (say 10%) instead of market value. That changes both the economics and possibly the tax treatment.
• Payments due at signing. First-and-last-month or security deposits raise the effective rate.
• End-of-lease costs. Return shipping, excess-wear charges and required notice periods can add real money to an FMV lease.
• Automatic renewal. Miss the notice window and some FMV leases renew month to month at the same payment.
• Accounting treatment. Under current US lease accounting standards, most leases longer than 12 months appear on the balance sheet either way, so “off-balance-sheet” is rarely a reason to choose one type over another. Ask your accountant.

Try it

The lease vs. buy calculator handles both lease types. Switch between “Fair market value” and “$1 buyout” and it works out the implicit rate, the tax effects and the after-tax cost in today’s dollars against buying with a loan.